SMEs: Where's the tech liquidity solution?
Although the majority of banks believe fintech will cut their compliance costs and improve their ability to risk-assess SMEs, the proportion of small businesses being rejected for trade finance continues to rise. What do fintechs and traditional trade financiers need to focus on to get money flowing to SMEs?
The fintech world is making great efforts towards reducing the SME funding gap, and the potential impact of technology like blockchain is “very exciting,” but progress is neither fast nor coordinated enough, says Steven Beck, head of trade and supply chain finance (SCF) at the Asian Development Bank (ADB). Many “assumed that fintech would start to eat into this gap, but there’s no evidence that that’s happening,” he adds. “On the contrary, it doesn’t seem to be having any impact.”
Although the global trade finance gap overall is finally shrinking – to $1.5 trillion from $1.6 trillion last year – this is not the case for SMEs, according to the ADB’s latest annual survey. And while the number of digital finance platforms, many of which promise to tackle the SME funding gap directly, continues to proliferate, just 20% of firms report having used one.
The idea was that fintech would reduce the costs of lending to small companies and therefore encourage banks to do so, Beck notes. However, while cost reduction is a good thing, “it’s just one piece of the puzzle.”
Supply chain businesses’ slowness to digitise is limiting fintech’s impact, while a lack of common standards for new technologies like blockchain also means disparate pilots are taking place mostly in isolation, Beck says. Systems that are not interoperable cannot talk to each other to integrate information. And legal and regulatory uncertainties around digitisation are another obstacle, he adds.
This lack of infrastructure makes it hard for fintechs to adequately address banks’ know your customer (KYC) or anti-money laundering (AML) due diligence requirements around SMEs, Beck argues.
If fintech innovations do lead to the creation of huge pools of meta-data that lenders could use for KYC, AML or performance risk checks, mining that data without a simple, reliable way of identifying SMEs would still be painfully slow.
“It’s like the internet before Google – it was just a whole jumble of stuff and you couldn’t find anything,” he says.
Efforts are however underway. The Financial Stability Board’s creation in 2014 of the Global Legal Entity Identifier Foundation (GLEIF), which provides 20-digit numbers that uniquely identify companies, will help, Beck says. But with just 600,000 companies signed up so far, harmonised global adoption is essential.
The International Chamber of Commerce’s B20 consultation to the G20, which Beck co-chairs, is pushing for governments to make it a legal requirement for all companies to acquire a legal entity identifier.
The World Trade Board’s Digital Standards in Trade initiative – which aims to create a common set of standards for digital trade by filtering existing standards and merging those that overlap – will also help SMEs enjoy the benefits of digitisation, he adds.
The potential is there
Tony Brown, founder and CEO of The Trade Advisory, is more upbeat about fintech’s near-term potential to reach SMEs.
The reasons for the SME funding gap are well documented. Weighed down by regulatory compliance burdens and restricted by Basel capital requirements, “banks are caught like deer in headlights,” he says. This makes less money available for smaller companies that banks consider higher risk and less lucrative to serve.
Insufficient legal infrastructure in markets like Bangladesh, Indonesia and Vietnam, whose low labour costs have enabled small suppliers of low-tech products like toys or apparel to win market share from China, create a further obstacle to financing those exporters.
Many emerging markets do not even have a collateral registry system for receivables, preventing them from using their biggest asset – their receivables – as collateral to access finance, he notes.
Digital innovations however have the power to transform SMEs’ access to funding as trade, finance and logistics data – historically opaque or stranded in silos - become available for combined analysis, Brown argues.
While merchant banks of the past lent to a transaction based on their control of inventory and their trust in the parties involved, future trade financing will be based on an assessment of historical trading experiences evidenced by data, he says. Using this to predict future experiences will make lenders less risk-averse.
Being able to track the trading experience between a manufacturer and a buyer over years – to see that the product is consistently delivered on time, on spec and without problem, that it is sold through to end-buyers without dispute and returns, and that suppliers have complied with regulations related to child or product safety – gives lenders a “warm and cosy feeling about providing finance, without having to look in the rear-view mirror all the time,” he says.
Reaching the long tail
Teaming up with fintechs allows banks to analyse a wealth of data, says Vinay Mendonca, global head of product and propositions, trade and receivables finance at HSBC. It also helps them overcome what was previously a big obstacle to facilitating SCF to all but the top 20% of a large company’s suppliers: being able to conduct KYC due diligence and onboard them more efficiently.
In July 2017, HSBC inked a deal with cloud-based business applications provider GT Nexus that saw the bank’s SCF capabilities integrated into GT Nexus’s supply chain management platform for HSBC customers.
This followed a partnership forged in March with San Francisco-based fintech Tradeshift that allows the bank’s customers to manage their global supply chains and working capital requirements on one digital platform, combining electronic invoicing, document matching and early payment capabilities.
In these deals – which both came in response to demand by HSBC’s clients to help them support smaller suppliers - new technology allows physical and financial supply chains to truly come together, making the SCF process more seamless and inclusive, says Mendonca.
With a partner like Tradeshift, for example, SME suppliers can be onboarded in under 24 hours, he says.
There are numerous structural obstacles that make it harder for SMEs to access SCF, and which fintechs can help them overcome, according to Maxim Rokhline, senior vice president, financial services at Tradeshift.
Designed to help banks maximise the utilisation of their own SCF programmes, Tradeshift’s platform is capable of converting more than 60 document and format types including invoices, warehouse receipts and shipment certificates into digital form and processing them.
It also provides third-party authentication, allowing documents to be delivered from the ERP system of one entity to that of another and digitally signed. And because it processes so many documents, it captures data about every single trade event related to its clients and their customers, and can provide this information to banks to improve their decision-making, Rokhline says.
Although Tradeshift cannot conduct KYC due diligence on behalf of banks, it is able to pre-aggregate KYC-level data for them to speed up the process, for example pulling up the Office of Foreign Assets Control (OFAC) or Politically Exposed Persons (PEP) report and displaying it on the screen for the bank’s underwriter to see.
It also helps banks tackle SMEs’ poor awareness of the financial options available to them, says Rokhline. Banks on their own struggle to engage with SMEs effectively, for example relying on email or even physical mail – which often remains unopened – to educate overseas suppliers about their clients’ SCF programmes, he says.
Tradeshift has built a number of applications for suppliers into its platform – as well as allowing them to send invoices and receive purchase orders, it offers everything from labelling to accounting support, all for free – meaning many log into the platform several times a day.
Just like Facebook therefore, it has their attention, Rokhline says. And based on all the information it has collected about them – including everything from their credit history to the rate they pay for current facilities – it is in a unique position to make proposals to them, for example by pointing out mismatches in their payables and receivables.
This level of engagement gives Tradeshift unique access even to tiny suppliers, helping ensure buyers onboard the “long tail” of suppliers, Rokhline says. And by making the process easier for banks, it enables many of them to reduce their financing rates.
One obstacle for SME funding is a lack of accurate credit-scoring for smaller corporates, says Ken So, co-founder and CEO at San Francisco-based AI start-up Flowcast. This is particularly the case in emerging markets and even the US, where just 10% of companies are scored by credit bureaus D&B and Experian.
At the same time, corporates and B2B networks have a wealth of transaction data at their fingertips that is barely used beyond accounting and financial reporting purposes.
Applying machine learning to this data could enable banks and non-bank funders to assess performance risks of individual supply chain transactions, allowing them to extend their lending capacity for clients of all sizes, So says.
Flowcast is also exploring how it might make purchase order and pre-shipment type financing “much more effective and scalable.”
In the same way that Netflix predicts which films subscribers will enjoy, Flowcast taps into transaction flows to predict the performance of a supplier-led transaction, he says. “By leveraging data and machine learning algorithms, we empower funders to make real-time financing decisions based off transaction performance scores.”
The model helps small distributors in emerging markets like India or Africa access working capital that was not previously available through traditional credit processes for the purchase of goods from consumer packaged goods giants.
Flowcast has already progressed through its pilot phase with large multinational banks and expects to enter production in Q1.
The power of data
Advances in data gathering and analytics are enabling companies like Hong Kong-based Seabury TFX – which operates a closed platform connecting suppliers with potential investors, lenders and warehouse facility operators – to help money flow to SMEs earlier on in the trade cycle when they need it most, says its president and CEO Robert Lin.
As well as gathering historical data related to the suppliers’ sales – for example purchase orders, invoices issued, and any payment data available – to analyse their past performance, Seabury uses ongoing data to evaluate current performance and check for consistency between the two, he says.
The data is sourced from suppliers and system providers like GT Nexus and is used to help funders make lending decisions.
Most suppliers on Seabury’s platform are Asia-based exporters, many of them supplying finished consumer product goods to retailers or brands in developed countries. The majority have no other access to finance and need the funds – which typically arrive at time of shipment, invoice or even pre-shipment – to procure raw material or components for their products.
“This provides them with access to funding where it didn’t exist previously,” Lin says.
The adoption of electronic invoicing in jurisdictions like Mexico, Brazil and some Scandinavian countries is creating rich databases that Seabury can mine for historical analysis while allowing funders to better validate current transactions, Lin says. The development of better KYC databases also helps it obtain better information on companies, their directors and shareholders.
Having originated and serviced more than 10,000 transactions, Seabury is now looking to open up its platform to a more exchange-type model. It has also attracted interest from other companies looking to license parts of its technology, Lin says.
The fanfare around fintech makes it tempting to overlook the support SMEs enjoy from more traditional players and the opportunities here for innovation. That would be a mistake.
Products like just in time inventory financing would support SME trade, says Brown. Allowing buyers to avoid taking ownership of inventory until after it is delivered would encourage them to order more from SMEs, he argues.
ECAs too “have a phenomenal role” to play in facilitating SME trade. UKEF used to offer banks a guarantee to finance receivables that were credit insured, he notes. Resurrecting this would be “immensely helpful.”
The Export-Impact Bank of the United States’ working capital guarantee programme meanwhile provides support that is “far more aggressive and compelling than would be obtainable from a bank on an asset-based lending proposition,” Brown says.
US Eximbank’s “very strong” export credit insurance programme is its most widely used product by SMEs, allowing them to enter new markets and supply larger buyers that might otherwise be out of reach, says Regina Gordin, deputy managing director, Eastern Region. This is an area that private sector insurers usually find to expensive to serve, she adds.
“I know the power these programmes bring,” adds Gordin. “I can see companies double, triple or even quadruple their exports, and maybe go into markets that they otherwise would not have. I see it and live it every day.”
A current focus for US Eximbank is finding better ways to support SMEs that, rather than exporting a hard product, provide a service such as website design or sell their intellectual property overseas. Often in the tech sector, these kinds of SMEs represent a growing part of US Eximbank’s portfolio.
“It is much more difficult to get a handle on what exactly is the export, how do we finance it and in some cases how do we insure it,” Gordin says. “For some industries it’s harder to define.”
The availability of finance is of course not the only obstacle that prevents SMEs from exporting more. ECAs like US Eximbank put in a lot of legwork to make SMEs aware that exporting is an option and help them navigate various routes, says Gordin.
In the US – where SMEs are historically less exposed to the idea of exporting than their peers in Europe – “it’s part of the educational process of getting people to understand that it is a global economy,” she says. “How do we get them to that 95% of the world that’s outside of the US, and how do we get them more comfortable exporting?”